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ELIMINATE CONFLICT OF INTEREST IN CORPORATE MANAGEMENT

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To minimize the scope for embezzlement and misuse by promoter management against the interests of various other stakeholders in listed companies of the corporate sector, the government has introduced, at different points of time, the requirement of changing the statutory auditors every five years, appointment of Independent Directors to the Board and evaluation by a recognized credit rating agency for credit worthiness of the company. These requirements are introduced in the interest of fairness to all other stakeholders like minority shareholders who have neither the access to the detailed financial information nor the ability to evaluate the available information.

In spite of such provisions, scams like that of M/s Satyam Computer Services Ltd., took place. Satyam scam came to light only when the Chairman of the company himself confessed. Independent Directors have hardly played their intended roles, though some of them were experts in their fields. M/s Zylog and M/s Glodyne Technoserve can be some examples in small-cap/mid-cap sectors. Minority Investors had no clue, what so ever, about what is going on inside these companies until it is too late for them to safeguard their investments. Because the Independent Directors(IDs) are appointed by the Promoters, and the companies promoted by them are paying compensations to the IDs, these IDs feel more obligated to the promoters rather than to comply with the statutory requirements, though they are appointed for complying with the regulatory requirements. So the convenient option chosen by the IDs is to close their eyes for whatever might be happening in the company to avoid any controversy, as they are not made accountable statutory for not complying with the statutory obligations.

About Credit Rating Agencies also, the appointment is made by the promoters and their fee is paid by the companies of the same promoters. So these credit rating agencies are likely to feel more obligated to the promoters rather than the statutory duties, and hence they are likely to compromise their valuation reports in favour of the management of the company they evaluate. Sub-prime crisis in USA happened mainly because the credit rating agencies compromised in their evaluations. Another interesting example in India is that of M/s Opto Circuits (India) Ltd. In August 2012, ICRA revised its rating of AA- to B and then suspended its rating on the grounds of insufficient information furnished by the company. The management of the company dropped ICRA saying that they don’t agree with ICRA, and appointed M/s BRICKWORK Ratings who evaluated them to Triple B+ in November 2012 . The rating agency M/s BRICKWORK downgraded the rating of M/s Opto Circuits in June 2015 to D. In the meantime minority investors were totally confused to lose quite heavily due to unexpected significant drop in the share price. In such cases who should be made accountable - the promoters, who can keep changing the evaluators until they find an agency prepared to compromise, or the agency who compromises, or both?

 Satyam scam was unlikely to have happened if the appointed Statutory Auditors had not compromised with their statutory obligations. Some key members of the Satyam appointed auditor firm had to be indicted by the court due to non-compliance with their duties.

Conflict of interest is inherent in the present system of appointing the IDs, the Rating agencies and the Statutory Auditors, because the promoters have the total discretion to appoint and pay the compensation. Therefore if the inherent conflict of interest built in the present system is eliminated, it goes a long way in not only protecting the fair interests of the minority investors but also in minimizing the corruption and embezzlement prevailing in the corporate sector in the country.

SEBI is the regulator to ensure that the listed companies are managed fairly without being prejudicial in favour of the promoters. And the basic purpose of appointing the statutory auditors, IDs and the Rating agencies for evaluation of the companies for credit worthiness, is also to ensure fairness in management of the companies. Therefore it is only appropriate that the function of appointing these, namely statutory auditors, IDs and evaluating agencies, be assigned to SEBI in line with their basic purpose. Even the salaries / compensations to the auditors, IDs and the evaluating agencies should be made disbursed by SEBI, and the concerned companies should reimburse those amounts to SEBI.

Infosys, when the founders were managing the Company, was known to be closest to having the ideally ethical management that ever existed in India. Now, after the founders have left the management, lot of controversies have been floating in the news regarding the appointment of politically influential person as an ID. So, it is essential to include as one of the conditions to be eligible to become an ID is that the individual should not be a person in politically influential position and /or related to such person.

Role of Auditors, apart from statutory requirements, is defined and /or modified from time to time by the Institute of Chartered Accountants of India. Whereas the role of IDs are not defined, and so needs to be clearly defined by SEBI. It should also be made mandatory for the IDs to periodically report to SEBI on the decision making process conducted during the Board meetings, the role played by the IDs themselves in those meetings and the report should also include whether the decisions taken are tilted in favour of the promoters in conflict with the interests of any or all other stake holders including minority shareholders, environment, ethics of business etc. SEBI can perhaps help them by making a standard format of report to be submitted by the IDs.

In case the promoters have any problem with the IDs or the Rating Agency, they could take up with SEBI for resolution of issues.

In reality there are not enough competent people to take up the position of IDs within the country. To facilitate better choice of competent people, SEBI may classify the various listed companies into different categories depending on the complexities involved in managing the companies like technical complexity, complexity of network of inter-company investments within the relevant group etc., and accordingly categorize the eligible people available depending on the degree of expertise they possess. Perhaps SEBI can tap the academic people for selection of IDs as an adhoc measure.  Wherever enough number of sufficiently competent people are not available, SEBI may even consider competent people available from outside the country for appointment as IDs for higly complex managements. To meet the long time requirement, SEBI may even think of designing some training programs for increasing the number of competent people available as well as improving the competency of the available people. All these appointments should be mandatory to rotate as being done for statutory auditors to minimize the probability of developing any nexus between the appointees and the respective promoters.

To ensure that the promoters do not kill any choice of SEBI by their brute majority in the Shareholders meeting for regularization, it should be made mandatory that only members, other than promoters, are eligible to vote in the share holders’ meeting for approval of the SEBI nominations of IDs, Statutory Auditors and Rating agencies.

Such a provision does not go against the fairness towards the promoters because being fair for all other stakeholders would also mean it is fair to the promoters. It is also essential that the Board has members who take care of the interests of stakeholders other than promoters, since all the other Directors in the Board are chosen by the Promoters, and hence the promoters are well represented by the majority in the Board. Since the obligations of the above appointees are only to ensure that affairs of the companies are fair and transparent to ensure the fair interests of all the stake holders, it does not go against the promoters to manage fairly and efficiently.

Therefore we appeal to the Government and SEBI to make it mandatory that SEBI incorporate the above requested condition for choice of IDs, in addition to the various existing conditions, and that SEBI be empowered to nominate and periodically rotate the following for the listed companies:

1. Independent Directors,

2. Evaluating /Rating Agencies, and

3. Statutory Auditors.



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